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Question
Discuss the mechanism of investment multiplier with the help of a numerical.
Solution
Investment multiplier is the number of times income rises due to a rise in the investment expenditure in the economy. It is represented as (K).
The working of multiplier is based on the assumption that one man's expenditure is another man's income.
Suppose, Government of the country, spends ₹ 100 crores on the construction of road i.e. Δ I = ₹ 100. The first impact is that it increases the income of the workers engaged in the work by ₹ 100 crores.
Assuming MPC = 0.75, the workers will spend 75 crore i.e. 0.75 × 100 on consumer goods. The producers of these goods will have an additional income of 75 crores. This additional income will be spend on goods i.e. 0.75 × 75 = ₹ 56.25 crore:
This process will continue, till the change in income becomes equal to multiple times the change in investment.
Hence,
| Rounds | AI | AY | AC |
| I | 100 | 100 | 75 |
| II | 75 | 56.25 | |
| III | 56.25 | 42.18 | |
| : | : | ||
| Total | 400 | 300 |
K = `1/(1 - "MPC")`
`= 1/(1 - 0.75)`
= 4
K = `(Delta "Y")/(Delta "I")`
`4 = (Delta "Y")/100`
Δ Y = ₹ 400
Additional income = ₹ 400
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